With four big banks that have a combined market captilalisation of about $250 billion, and control 80 to 90 per cent of all Australian financial transactions, and dominate the planning and funds management industries, it’s understandable they attract attention.

But don’t blame the bankers. By choosing to pass on their costs to the 5 million families who have home loans, and to millions of small business borrowers, rather than absorbing these costs themselves, they are simply doing what all good oligopolists do: exploiting market power.

They are aiming to preserve world-beating, double-digit returns on equity for the benefit of themselves and their shareholders. That’s rational.

The answer to Australia’s banking problems lies not with bank executives, who have but one sensible objective – profit maximisation. The answer rests with policymakers, who urgently need to revisit the industry’s dangerous and inequitable incentives, which are exposing the nation to greater moral hazards and sub-optimal financial services.

Banking is a simple business: those with the lowest funding costs generally win. The Australian banking system encourages extreme size, since the bigger you are, the lower your costs will typically be. The majors are so large these days they are explicitly treated by investors as “too big to fail”.

In particular, they benefit from a two-notch rating upgrade, which none of their smaller rivals receive, because Standard & Poor’s assumes that they alone will get “extraordinary government support”.

Unfortunately, the banking debate is characterised by confusion cleaved between two camps. There are those who pretend banks are just like normal private companies, and should not be interfered with. These folk like to claim that the banks need not receive much taxpayer assistance during the crisis.

In the other camp, we have those who understand that banks are public-private utilities performing a vital social function –transforming short-term savings into long-term loans – that gives rise to “asset-liability mismatches” that inevitably require public backing.

ANZ Banking Group chairman John Morschel underscored this divide last week, remarking, “I wish politicians would get their facts straight . . . There was no capital provided to any Australian bank by the government and the only thing they did was guarantee wholesale funding, for which they . . . earned a hell of a lot of money.”

This is incorrect. In addition to guaranteeing more than $100 billion of wholesale bank debts for the first time (at sub-market fees), taxpayers also guaranteed the banks’ biggest source of funding – retail deposits – free of charge. Without the latter, Treasury feared there may have been bank runs, which could have triggered domino effects across larger institutions.

And who were the biggest users of the wholesale guarantees? The big banks, of course. The likes of Bendigo and Adelaide Bank couldn’t afford to rely on them as the guarantee was, perversely, priced on the banks’ credit ratings, which made them mechanically cheapest for bigger entities to use.

The Australian Competition and Consumer Commission also set aside competition concerns during the global financial crisis, green-lighting a swath of major bank purchases, including St George, Bankwest, RAMs, one-third of Aussie Home Loans, indirectly Wizard Home Loans, and Challenger’s lending business.

The ACCC’s new boss, Rod Sims, worries: “Even though there are four of them, there is a lack of full and effective competition . . . I think [they] feel . . . protected from others entering the market and that makes for arrangements that are too cosy for consumers.”

Finally, our taxpayer-owned bank, the Reserve Bank of Australia, which describes itself as a “lender of last resort” to private banks, supplied billions of dollars of cheap money to the banks when nobody else was willing to do so.

Once in a while, bankers acknowledge that their solvency is vouchsafed by us all. “The guarantee underlined the privileged position that banks have in the economy and that . . . the state will step in to support them,” National Australia Bank’s executive director of finance, Mark Joiner, concedes.

“It has shone the light on the obligations on banks not only to act in their own self-interest but to keep in the front of their mind they have obligations to all stakeholders.”

The real trouble with this banking system is that it’s based on a flawed paradigm: a purported conflict between stability and competition, which the big banks highlight when justifying their margin expansion.

Yet these two objectives are, in fact, complementary. The financial system would be safer if we had 10 smaller banks worth $25 billion each, so that none is individually big enough to threaten the system’s viability compared with the four too-big-to-fail behemoths, worth about $250 billion combined, that we have today.

In a similar vein, Bendigo and Adelaide Bank chairman Robert Johanson argues, “We went into the crisis with no bank too big to fail . . . Coming out of it, I don’t think that’s the case . . . We’ve ended up with an industry structure that’s far more rigid, and . . . more vulnerable to the next shock.”

Policymakers should accept that government guarantees of banks are a prerequisite for safe “maturity transformation”. But this taxpayer insurance must be properly priced, or you encourage a US-style situation whereby a handful of implicitly government-backed lenders dominate financial intermediation to the detriment of competition and stability.

When extending liquidity and insurance to banks, Treasury or the RBA should not rely on ratings agencies. The Australian Prudential Regulation Authority monitors and controls every bank’s risk, and the cost of taxpayer support should be APRA’s intrusive regulation, and thus priced the same for all institutions.

In preference to guaranteeing nebulous “institutions”, taxpayers should focus on insuring safer assets. If the government offered a credit-wrap of mortgage loss insurance like the Canadians do, it would formally price an implicit guarantee that already exists (generating substantial revenue) while levelling the playing field.

This would allow all banks to raise capital on similar terms and help eliminate the too-big-to-fail advantages that the majors now have. The Australian Securities and Investments Commission chairman, Greg Medcraft, also supports this.

Finally, why not require all banks to publish a regular index of their funding costs and net interest margins to end the asinine monthly RBA rate debate. We’re surprised the majors haven’t offered to do so.

Mark Bouris is the executive chairman of Yellow Brick Road, and Christopher Joye is a fund manager and economist.